Investing’s new golden rule

Commentary: Rethink rules of thumb on the yellow metal

Once upon a time, asset allocation for an individual investor amounted to a simple formula: stocks, bonds, cash and gold.

The financial rule of thumb involved keeping 5% to 10% of a portfolio in gold, as a salve for uncertain economic times — a hedge against inflation, currency risk, and political and socioeconomic troubles.

As asset allocation evolved to where investors could slice and dice the world into precise slivers and varied exposures, the rule about holding gold started slipping away: The traditional gold allocation rule was cut back from 10% of assets down to 5% when it didn’t seem to work so well over the course of the 1980s, and it continued to decline until going virtually extinct during the bull market of the 1990s. It re-emerged — perhaps as an alibi for chasing performance — as gold bounced back strong when the Internet bubble burst. For the better part of the past decade — fueled by easier access and trading thanks to the emergence of exchange-traded funds — average investors and professional money managers have adopted the standard gold allocation.

Gold's unglittering wasn't a surprise to some

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The gold-price rout began taking shape in the early morning hours Monday, after a sharp Friday selloff in a market that had risen steadily for a decade. Charles Forelle reports. Photo: AP

But as gold suffered a catastrophic decline on Monday — falling more than 9% in its worst single-day decline in 30 years — investors were again rethinking whether gold deserves a seat at their investment table.

This isn’t about gold bugs, traders or people who want to make tactical bets on precious metals, but rather about average joes deciding if they can keep a piece of their assets in something that, historically, hasn’t done a great job of fulfilling the role it has been purchased for.

“Gold is very volatile and extremely difficult for the average investor to handle and hold on to,” says veteran investor Bill Nasgovitz, who has run Heartland Value for nearly 30 years, and who says he bought gold for his own portfolio during this week’s implosion. “But the big picture, to me, just pounds the table that you have to have some representation in gold with the craziness that is going on with the Western world’s central banks, and the money easing that has reached epic proportions, and the currency debasements and more.”

“But making a case that there’s a reason to hold gold in a portfolio doesn’t mean most people can do it and generate some gains from it,” he adds. “If all you are doing is chasing gold around, you’re probably losing money on it all of the time.”

While gold allocators, like Nasgovitz, can see how others would avoid the metal rather than lose money on it, the other side — the people who don’t believe gold should have that historical, rule-of-thumb allocation — are not so charitable.

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They use words like “non-productive asset” to describe precious metals, noting that an allocation in gold does not generate interest, dividends, or rent while it’s in the portfolio. While an investor might opt to buy gold-related stocks such as mining companies to generate some income, gold’s critics say mining companies are like any other sector of the market — something to own only if and when it makes tactical sense.

Moreover, the experts who avoid gold say they don’t want it because it can’t be valued based on earnings, cash flow or other traditional metrics but instead gets priced based on emotions, which explains its historic volatility.

Combined, that makes a strong case that investors don’t need an allocation to precious metals, though they may want one.

“We do not consider precious metals an essential element of a permanent asset allocation,” says Dan Dorval of Dorval & Chorne Financial Advisors in Otsego, Minn. “We tend to favor other physical assets such as real estate that offer similar protection against inflation and may offer an attractive income stream in the process.” One client that for years wanted an increased allocation in gold and precious metals recently contacted the firm wanting to get out of gold.

For most investors, that is precisely how precious-metals investing has worked. Over the past century, gold has had at least 10 strong runs, followed by massive sell-offs; average investors who wavered on the “commit to gold” philosophy wound up buying in after the rise was started, and selling out after the gains were beaten out of their portfolios.

Ultimately, for someone committed to a steady allocation to gold, now is the time to rebalance, buying more when it’s down to maintain the percentages; but if an investor failed to take profits when gold was up and the allocation to precious metals grew too large, and if he can’t stomach the idea of hanging in now, he should forget about any rule of thumb and any allocation to gold.

Notes Oliver Pursche, co-manager of the GMG Defensive Beta fund
MPDAX, -0.15%
: “The bottom line is that a 3% to 6% exposure to a long-term portfolio has many merits; in the short-term however, expect continued volatility and most likely further losses.”

If you can’t live with those consequences and sleep at night, the rule of thumb should be: Your portfolio will be better off without gold.

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